A Tax-Subsidy Scheme for Efficient Investment in Renewable Generation Capacity

TL;DR

This paper proposes a combined tax-subsidy scheme to promote efficient renewable energy investment by internalizing externalities and incentivizing socially optimal capacity, without increasing regulatory complexity.

Contribution

It introduces a novel tax and subsidy framework that aligns producer incentives with social welfare in renewable energy markets.

Findings

The Pigouvian tax reduces pollution externalities and influences prices.

Subsidies based on consumer surplus encourage renewable investments.

The scheme does not increase regulator's information requirements.

Abstract

The impact of energy production significantly affects system sustainability, which has enabled a shift towards renewable energy sources. Thus, producer behavior is crucial in electricity markets to achieve sustainability goals. In this paper, we address two key challenges comprising electricity markets and generation investment. Firstly, electricity markets typically are operated with competitive market clearing and merit-order dispatch, which neglects negative externalities from pollution. A Pigouvian tax is proposed in order to investigate the impacts of these externalities on electricity prices and resolve this issue. Secondly, renewable energy sources entail low operational costs, which result in lower system prices and reduced profits for producers. Furthermore, producers face high investment costs when moving into renewable energy resources, which leads to strategic investment decisions. In order to mitigate this strategic behavior, subsidies are proposed equal to producers' contribution to consumer surplus. These subsidies incentivize producers to decrease prices and increase consumer surplus, so, producers would be motivated to invest in socially optimal generation capacity. Finally, we demonstrate that implementing the proposed tax and subsidy does not increase the regulator's information burden.